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An initial insurance purchase, such as homeowners buying a policy to cover damage to their home, is often only the first transfer of that risk. The initial (or primary) insurer may then transfer (or cede) some or all of this risk to another company or investor, such as a reinsurer. Reinsurers may also further transfer (or retrocede) risks to other reinsurers. Such transfers are, on the whole, a net cost for primary insurers, just as purchasing insurance is a net cost for homeowners. \nThe Homeowner Flood Insurance Affordability Act of 2014 (P.L. 113-89) revised the authority of the National Flood Insurance Program (NFIP) to secure reinsurance from \u201cprivate reinsurance and capital markets.\u201d Risk transfer to the private market could reduce the likelihood of the Federal Emergency Management Agency (FEMA) borrowing from the Treasury to pay claims. In addition, it could allow the NFIP to recognize some of its flood risk up front through premiums it pays for risk transfers rather than after-the-fact borrowing, and could help the NFIP to reduce the volatility of its losses over time. However, because reinsurers charge premiums to compensate for the assumed risk as well as the reinsurers\u2019 costs and profit margins, the primary benefit of reinsurance is to manage risk, not to reduce the NFIP\u2019s long-term fiscal exposure.\nReinsurance\nThe most common form of risk transfer is a primary insurer purchasing coverage for its risks from another (re)insurer. Reinsurance is particularly important to smaller insurers who may not be large enough to spread correlated local risks, such as a storm hitting a specific area. Reinsurers generally have the size to diversify risks globally. \nNFIP Reinsurance Purchases \nThe NFIP\u2019s first large reinsurance purchase was in 2017, with additional purchases in 2018, 2019, and 2020. The details of these purchases have varied, but they have all covered losses from a single flooding event starting at $4 billion and going up to $8-$10 billion, with potential payouts of $1.042-$1.46 billion and premiums of $150-$235 million. Claims from Hurricane Harvey exceeded $10 billion, triggering a full claim of $1.042 billion on the 2017 reinsurance. No claims were made on the 2018 or 2019 reinsurance.\nCatastrophe Bonds\nIn addition to reinsurance, new forms of \u201calternative\u201d risk transfer have also developed. One category of such instruments are known as insurance linked securities (ILS)\u2014financial instruments whose values are driven by insurance loss events and which transfer major natural disaster risks to capital market investors. The most common form is catastrophe bonds (or cat bonds), which operate somewhat like other bonds, but whose payout is dependent on the occurrence of a particular catastrophe.\nCatastrophe bonds are structured so that payment depends on the occurrence of an event of a defined magnitude or that causes an aggregate insurance loss in excess of a stipulated amount. Only when these specific triggering conditions are met do investors begin to lose their investment. There are three main types of triggers:\nIndemnity\u2014bonds triggered by the losses experienced by the sponsoring insurer following the occurrence of a specified event (e.g., if an insurer\u2019s residential property losses from a hurricane in Florida exceeds $25 million in 2018);\nIndustry Loss\u2014bonds triggered by a predetermined threshold of industry-wide losses following the occurrence of a specified event (e.g., if a total of all insurers\u2019 residential property losses from floods in 2018 exceeds $20 billion); or \nParametric\u2014bonds triggered by physical conditions occurring during a disaster such as wind speed or earthquake size (e.g., if a 25-foot storm surge hit New Orleans in 2018). \nCatastrophe bonds were first used in the mid-1990s following Hurricane Andrew and the Northridge earthquake. The public sector has become increasingly interested in the use of cat bonds. In 2009, Mexico became the first sovereign to issue cat bonds, and the World Bank is one of the largest participants in the market. The New York City Metropolitan Transit Authority issued cat bonds to protect against storm surge. According to Swiss Re, $9.7 billion in catastrophe bonds were issued in 2018 and $5.5 billion in 2019. \nNFIP and Catastrophe Bonds\nIn August 2018, FEMA entered into its first transfer of NFIP risk through an ILS transaction in the form of a three-year agreement with the reinsurer Hannover Re, with Hannover Re acting as a \u201ctransformer,\u201d transferring $500 million of the NFIP\u2019s risk to capital markets by sponsoring issuance of an indemnity-triggered cat bond. Hannover Re indemnifies FEMA for a portion of claims for a single qualifying flooding event between August 1, 2018, and July 31, 2021. The agreement is structured into two tranches. The first provides coverage for 3.5% of losses between $5 billion and $10 billion, and the second for 13% of losses between $7.5 billion and $10 billion. FEMA paid premiums of $62 million for each of years one and two. Unlike the earlier reinsurance purchases, which covered all NFIP flood losses, the catastrophe bond applies only to flooding resulting directly or indirectly from a named storm and covers only the 50 states, the District of Columbia, Puerto Rico, and the U.S. Virgin Islands. A storm comparable to Hurricane Katrina would result in a total loss for the catastrophe bond investors, while a storm comparable to Hurricanes Sandy or Harvey would erode the principal of both tranches but not cause a total payout. \nA second NFIP catastrophe bond was issued on April 16, 2019, transferring an additional $300 million of NFIP\u2019s financial risk to the capital markets. The agreement is structured to cover 2.5% of losses between $6 billion and $8 billion, and 12.5% of losses between $8 billion and $10 billion. FEMA paid premiums of $32 million for year one and $38 million for year two. A third NFIP catastrophe bond was issued on February 21, 2020. FEMA paid $50.28 million to transfer $400 million, structured to cover 3.3% of losses between $6 and $9 billion and 30% of losses between $9 and $10 billion.", "type": "CRS Insight", "typeId": "INSIGHTS", "active": true, "formats": [ { "format": "HTML", "encoding": "utf-8", "url": "https://www.crs.gov/Reports/IN10965", "sha1": "ac567ff4d7a13f5c3380d1d0950d79a7e330d8ea", "filename": "files/20200417_IN10965_ac567ff4d7a13f5c3380d1d0950d79a7e330d8ea.html", "images": {} } ], "topics": [ { "source": "IBCList", "id": 4845, "name": "Federal Emergency Management" } ] }, { "source": "EveryCRSReport.com", "id": 612485, "date": "2020-01-06", "retrieved": "2020-01-06T23:06:42.487048", "title": "The National Flood Insurance Program (NFIP), Reinsurance, and Catastrophe Bonds", "summary": "Insurance generally serves to transfer risk from one entity who does not want to bear that risk to another entity that does. An initial insurance purchase, such as homeowners buying a policy to cover damage to their home, however, is often only the first transfer of that risk. The initial (or primary) insurer may then transfer (or cede) some or all of this risk to another company or investor, such as a reinsurer. Reinsurers may also further transfer (or retrocede) risks to other reinsurers. Such transfers are, on the whole, a net cost for primary insurers, just as purchasing insurance is a net cost for homeowners. \nThe Homeowner Flood Insurance Affordability Act of 2014 (P.L. 113-89) revised the authority of the National Flood Insurance Program (NFIP) to secure reinsurance from \u201cprivate reinsurance and capital markets.\u201d Risk transfer to the private market could reduce the likelihood of the Federal Emergency Management Agency (FEMA) borrowing from the Treasury to pay claims. In addition, it could allow the NFIP to recognize some of its flood risk up front through premiums it pays for risk transfers rather than after-the-fact borrowing, and could help the NFIP to reduce the volatility of its losses over time. However, because reinsurers charge premiums to compensate for the assumed risk as well as the reinsurers\u2019 costs and profit margins, the primary benefit of reinsurance is to manage risk, not to reduce the NFIP\u2019s long-term fiscal exposure.\nReinsurance\nThe most common form of risk transfer is a primary insurer purchasing coverage for its risks from another (re)insurer. The primary insurer continues to service the initial policy, while the reinsurer operates in the background. Reinsurance is particularly important to smaller insurers who may not be large enough to spread correlated local risks, such as a storm hitting a specific area, across a broader geographic area. Reinsurers, however, often have the size to diversify risks on a global scale. \nNFIP Reinsurance Purchases \nThe NFIP\u2019s first large reinsurance purchase was in 2017, with additional purchases in 2018, 2019, and 2020. The details of these purchases have varied, but they have all covered losses from a single flooding event starting at $4 billion and going up to $8-$10 billion, with total potential payouts ranging from $1.042 billion to $1.46 billion. FEMA paid premiums ranging from $150 million to $235 million. Claims from Hurricane Harvey exceeded $10 billion, triggering a full claim of $1.042 billion on the 2017 reinsurance. No claims have been made on the 2018 or 2019 reinsurance.\nCatastrophe Bonds\nIn addition to reinsurance, new forms of \u201calternative\u201d risk transfer have also developed. One category of such instruments are known as insurance linked securities (ILS)\u2014financial instruments whose values are driven by insurance loss events and which transfer major natural disaster risks to capital market investors. The most common form is catastrophe bonds (or cat bonds), which operate somewhat like other bonds, but whose payout is dependent on the occurrence of a particular catastrophe.\nCatastrophe bonds are structured so that payment depends on the occurrence of an event of a defined magnitude or that causes an aggregate insurance loss in excess of a stipulated amount. Only when these specific triggering conditions are met do investors begin to lose their investment. There are three main types of triggers:\nIndemnity\u2014bonds triggered by the losses experienced by the sponsoring insurer following the occurrence of a specified event (e.g., if an insurer\u2019s residential property losses from a hurricane in Florida exceeds $25 million in 2018);\nIndustry Loss\u2014bonds triggered by a predetermined threshold of industry-wide losses following the occurrence of a specified event (e.g., if a total of all insurers\u2019 residential property losses from floods in 2018 exceeds $20 billion); or \nParametric\u2014bonds triggered by physical conditions occurring during a disaster such as wind speed or earthquake size (e.g., if a 25-foot storm surge hit New Orleans in 2018). \nCatastrophe bonds were first used in the mid-1990s following Hurricane Andrew and the Northridge earthquake. The public sector has become increasingly interested in the use of cat bonds. In 2009, Mexico became the first sovereign to issue cat bonds, and the World Bank is one of the largest participants in the market. The New York City Metropolitan Transit Authority issued cat bonds to protect against storm surge. According to the reinsurer Swiss Re, $9.7 billion in catastrophe bonds were issued in 2018. \nNFIP and Catastrophe Bonds\nIn August 2018, FEMA entered into its first transfer of NFIP risk through an ILS transaction in the form of a three-year agreement with the reinsurer Hannover Re. Hannover Re is acting as a \u201ctransformer,\u201d transferring $500 million of the NFIP\u2019s risk to capital markets by sponsoring issuance of an indemnity-triggered cat bond. Hannover Re will indemnify FEMA for a portion of claims for a single qualifying flooding event that occurs between August 1, 2018, and July 31, 2021. The agreement is structured into two tranches. The first provides coverage for 3.5% of losses between $5 billion and $10 billion, and the second for 13% of losses between $7.5 billion and $10 billion. FEMA paid a premium of $62 million for the first year of coverage. Unlike the earlier reinsurance purchases, which covered all NFIP flood losses, the catastrophe bond applies only to flooding resulting directly or indirectly from a named storm and covers only the 50 states, the District of Columbia, Puerto Rico, and the U.S. Virgin Islands. A storm comparable to Hurricane Katrina would result in a total loss for the catastrophe bond investors, while a storm comparable to Hurricanes Sandy or Harvey would erode the principal of both tranches but not cause a total payout. \nA second NFIP catastrophe bond was issued on April 16, 2019, transferring an additional $300 million of NFIP\u2019s financial risk to the capital markets. The agreement is structured to cover 2.5% of losses between $6 billion and $8 billion, and 12.5% of losses between $8 billion and $10 billion. FEMA paid a premium of $32 million for the first year of coverage.", "type": "CRS Insight", "typeId": "INSIGHTS", "active": true, "formats": [ { "format": "HTML", "encoding": "utf-8", "url": "https://www.crs.gov/Reports/IN10965", "sha1": "44581126ddf01b271ffd293e0242f840576c8d3b", "filename": "files/20200106_IN10965_44581126ddf01b271ffd293e0242f840576c8d3b.html", "images": {} }, { "format": "PDF", "encoding": null, "url": "https://www.crs.gov/Reports/pdf/IN10965", "sha1": "e57f2f45458dcdd47d465b97ad57a6cf8d0542cc", "filename": "files/20200106_IN10965_e57f2f45458dcdd47d465b97ad57a6cf8d0542cc.pdf", "images": {} } ], "topics": [ { "source": "IBCList", "id": 4845, "name": "Federal Emergency Management" } ] }, { "source": "EveryCRSReport.com", "id": 612069, "date": "2019-12-27", "retrieved": "2020-01-02T13:31:34.735968", "title": "The National Flood Insurance Program (NFIP), Reinsurance, and Catastrophe Bonds", "summary": "Insurance generally serves to transfer risk from one entity who does not want to bear that risk to another entity that does. An initial insurance purchase, such as homeowners buying a policy to cover damage to their home, however, is often only the first transfer of that risk. The initial (or primary) insurer may then transfer (or cede) some or all of this risk to another company or investor, such as a reinsurer. Reinsurers may also further transfer (or retrocede) risks to other reinsurers. Such transfers are, on the whole, a net expected cost for primary insurers, just as purchasing insurance is a net cost for homeowners. \nThe Homeowner Flood Insurance Affordability Act of 2014 (P.L. 113-89) revised the authority of the National Flood Insurance Program (NFIP) to secure reinsurance from \u201cprivate reinsurance and capital markets.\u201d Risk transfer to the private market could reduce the likelihood of the Federal Emergency Management Agency (FEMA) borrowing from the Treasury to pay claims. In addition, it could allow the NFIP to recognize some of its flood risk up front through premiums it pays for risk transfers rather than after-the-fact borrowing and could help the NFIP to reduce the volatility of its losses over time. However, because reinsurers charge premiums to compensate for the assumed risk as well as the reinsurers\u2019 costs and profit margins, the primary benefit of reinsurance is to manage risk, not to reduce the NFIP\u2019s long-term fiscal exposure.\nReinsurance\nThe most common form of risk transfer is a primary insurer purchasing coverage for its risks from another (re)insurer. The primary insurer continues to service the initial policy, while the reinsurer operates in the background. Reinsurance is particularly important to smaller insurers who may not be large enough to spread correlated local risks, such as a storm hitting a specific area, across a broader geographic area. Reinsurers, however, often have the size to diversify risks on a global scale. \nNFIP Reinsurance Purchases \nThe NFIP\u2019s first large reinsurance purchase was in 2017, with additional purchases in 2018 and 2019. The details of these purchases have varied, but they have all covered losses from a single flooding event starting at $4 billion and going up to $8 billion and up to $10 billion, with total potential payouts ranging from $1.042 billion to $1.46 billion. FEMA paid premiums ranging from $150 million to $235 million. Claims from Hurricane Harvey exceeded $10 billion, triggering a full claim of $1.042 billion on the 2017 reinsurance. No claims have been made on the 2018 or 2019 reinsurance purchases.\nCatastrophe Bonds\nIn addition to reinsurance, new forms of alternative risk transfer have also developed. One category of such instruments are known as insurance linked securities (ILS)\u2014financial instruments whose values are driven by insurance loss events and that transfer major natural disaster risks to capital market investors. The most common form is catastrophe bonds (or cat bonds), which operate somewhat like other bonds but whose payout is dependent on the occurrence of a particular catastrophe.\nCatastrophe bonds are structured so that payment depends on the occurrence of an event of a defined magnitude or that causes an aggregate insurance loss in excess of a stipulated amount. Only when these specific triggering conditions are met do investors begin to lose their investment. There are three main types of triggers:\nIndemnity\u2014bonds triggered by the losses experienced by the sponsoring insurer following the occurrence of a specified event (e.g., if an insurer\u2019s residential property losses from a hurricane in Florida exceeds $25 million in 2018);\nIndustry Loss\u2014bonds triggered by a predetermined threshold of industry-wide losses following the occurrence of a specified event (e.g., if a total of all insurers\u2019 residential property losses from floods in 2018 exceeds $20 billion); or \nParametric\u2014bonds triggered by physical conditions occurring during a disaster such as wind speed or earthquake size (e.g., if a 25-foot storm surge hit New Orleans in 2018). \nCatastrophe bonds were first used in the mid-1990s following Hurricane Andrew and the Northridge earthquake. The public sector has become increasingly interested in the use of cat bonds. In 2009, Mexico became the first sovereign to issue cat bonds, and the World Bank is one of the largest participants in the market. The New York City Metropolitan Transit Authority issued cat bonds to protect against storm surge. According to the reinsurer Swiss Re, $9.7 billion in catastrophe bonds were issued in 2018. \nNFIP and Catastrophe Bonds\nIn August 2018, FEMA entered into its first transfer of NFIP risk through an ILS transaction in the form of a three-year agreement with the reinsurer Hannover Re. Hannover Re is acting as a \u201ctransformer,\u201d transferring $500 million of the NFIP\u2019s risk to capital markets by sponsoring issuance of an indemnity-triggered cat bond. Hannover Re will indemnify FEMA for a portion of claims for a single qualifying flooding event that occurs between August 1, 2018, and July 31, 2021. The agreement is structured into two tranches. The first provides coverage for 3.5% of losses between $5 billion and $10 billion and the second for 13% of losses between $7.5 billion and $10 billion. FEMA paid a premium of $62 million for the first year of coverage. Unlike the earlier reinsurance purchases, which covered all NFIP flood losses, the catastrophe bond applies only to flooding resulting directly or indirectly from a named storm and covers only the 50 states, the District of Columbia, Puerto Rico, and the U.S. Virgin Islands. A storm comparable to Hurricane Katrina would result in a total loss for the catastrophe bond investors; a storm comparable to Hurricanes Sandy or Harvey would erode the principal of both tranches but not cause a total payout. \nA second NFIP catastrophe bond was issued on April 16, 2019, transferring an additional $300 million of NFIP\u2019s financial risk to the capital markets. The agreement is structured to cover 2.5% of losses between $6 billion and $8 billion, and 12.5% of losses between $8 billion and $10 billion. FEMA paid a premium of $32 million for the first year of coverage.", "type": "CRS Insight", "typeId": "INSIGHTS", "active": true, "formats": [ { "format": "HTML", "encoding": "utf-8", "url": "https://www.crs.gov/Reports/IN10965", "sha1": "2189ab65c5f2c58fd58357fa14ad7631c3d29745", "filename": "files/20191227_IN10965_2189ab65c5f2c58fd58357fa14ad7631c3d29745.html", "images": {} } ], "topics": [ { "source": "IBCList", "id": 4845, "name": "Federal Emergency Management" } ] }, { "source": "EveryCRSReport.com", "id": 596238, "date": "2019-04-11", "retrieved": "2019-12-20T19:32:32.888669", "title": "The National Flood Insurance Program (NFIP), Reinsurance, and Catastrophe Bonds", "summary": "Insurance generally serves to transfer risk from one entity who does not want to bear that risk to another entity that does. An initial insurance purchase, such as homeowners buying a policy to cover damage to their home, however, is often only the first transfer of that risk. The initial (or primary) insurer may then transfer (or cede) some or all of this risk to another company or investor, such as a reinsurer. Reinsurers may also further transfer (or retrocede) risks to other reinsurers. Such risk transfers are, on the whole, a net cost for primary insurers, just as purchasing insurance is a net cost for homeowners. \nThe Homeowner Flood Insurance Affordability Act of 2014 (P.L. 113-89) revised the authority of the National Flood Insurance Program (NFIP) to secure reinsurance from \u201cprivate reinsurance and capital markets.\u201d Risk transfer to the private market could reduce the likelihood of the Federal Emergency Management Agency (FEMA) borrowing from the Treasury to pay claims. In addition, it could allow the NFIP to recognize some of its flood risk up front through premiums it pays for risk transfers rather than after-the-fact borrowing, and could help the NFIP to reduce the volatility of its losses over time. However, because reinsurers charge premiums to compensate for the assumed risk as well as the reinsurers\u2019 costs and profit margins, the primary benefit of reinsurance is to manage risk, not to reduce the NFIP\u2019s long-term fiscal exposure.\nReinsurance\nThe most common form of risk transfer is a primary insurer purchasing coverage for its risks from another (re)insurer. The primary insurer typically continues to service the initial policy, while the reinsurer operates in the background. Reinsurance is particularly important to smaller insurers who may not be large enough to spread local risks that are spatially correlated, such as a storm hitting a particular area, across a broader geographic area. Reinsurers, however, often have the size to diversify risks on a global scale. \nNFIP Reinsurance Purchases \nThe NFIP\u2019s first large reinsurance purchase was in January 2017, and this was followed up with purchases in January 2018 and January 2019. The exact details of these reinsurance purchases have varied, but they have all covered losses from a single flooding event starting at $4 billion and going as high as $10 billion, with the total potential payouts ranging from $1.042 billion to $1.46 billion. FEMA paid premiums ranging from $150 million to $235 million. The year 2017\u2019s Hurricane Harvey resulted in more than $8.7 billion in losses, thus triggering a full claim of $1.042 billion on that year\u2019s reinsurance, while no claims have been made by the NFIP to date on the 2018 or 2019 reinsurance purchases.\nCatastrophe Bonds\nIn addition to reinsurance, new forms of \u201calternative\u201d risk transfer have also developed. One category of such instruments are known as insurance linked securities (ILS)\u2014financial instruments whose values are driven by insurance loss events and which transfer major natural disaster risks to capital market investors. The most common form is catastrophe bonds (or cat bonds), which operate somewhat like other bonds, but whose payout is dependent on the occurrence of a particular catastrophe.\nCatastrophe bonds are structured so that payment depends on the occurrence of an event of a defined magnitude or that causes an aggregate insurance loss in excess of a stipulated amount. Only when these specific triggering conditions are met do investors begin to lose their investment. There are three main types of triggers:\nIndemnity\u2014bonds triggered by the losses experienced by the sponsoring insurer following the occurrence of a specified event (e.g., if an insurer\u2019s residential property losses from a hurricane in Florida exceeds $25 million in 2018);\nIndustry Loss\u2014bonds triggered by a predetermined threshold of industry-wide losses following the occurrence of a specified event (e.g., if a total of all insurers\u2019 residential property losses from floods in 2018 exceeds $20 billion); or \nParametric\u2014bonds triggered by physical conditions occurring during a disaster such as wind speed or earthquake size (e.g., if a 25-foot storm surge hit New Orleans in 2018). \nCatastrophe bonds were first used in the mid-1990s following Hurricane Andrew and the Northridge earthquake. The public sector has become increasingly interested in the use of cat bonds. In 2009, Mexico became the first sovereign state to issue cat bonds, and the World Bank is now one of the largest participants in the catastrophe bond market. The New York City Metropolitan Transit Authority issued cat bonds to protect against storm surge. According to the reinsurer Swiss Re, $9.7 billion in catastrophe bonds were issued in 2018. \nNFIP and Catastrophe Bonds\nOn August 1, 2018, FEMA entered into its first transfer of NFIP risk to private markets through an ILS transaction, in the form of a three-year agreement with Hannover Re, a reinsurance company. Hannover Re is acting as a \u201ctransformer,\u201d transferring $500 million of the NFIP\u2019s financial risk to the capital markets by sponsoring issuance of an indemnity-triggered cat bond. Hannover Re will indemnify FEMA for a portion of claims for a single qualifying flooding event that occurs between August 1, 2018, and July 31, 2021. The agreement is structured into two tranches. The first provides reinsurance coverage for 3.5% of losses between $5 billion and $10 billion, and the second for 13% of losses between $7.5 billion and $10 billion. FEMA paid a premium of $62 million for the first year of coverage. Unlike the earlier reinsurance purchases, which covered all NFIP flood losses, the catastrophe bond applies only to flooding resulting directly or indirectly from a named storm and covers only the 50 states, the District of Columbia, Puerto Rico, and the U.S. Virgin Islands. A storm comparable to Hurricane Katrina would result in a total loss for the catastrophe bond investors, while a storm comparable to Hurricanes Sandy or Harvey would erode the principal of both tranches but not cause a total payout. It has been reported that a second cat bond issue will be forthcoming, but FEMA has not posted any official information regarding this.", "type": "CRS Insight", "typeId": "INSIGHTS", "active": true, "formats": [ { "format": "HTML", "encoding": "utf-8", "url": "https://www.crs.gov/Reports/IN10965", "sha1": "9e933b436f8b2a6d16b364f6d338d5159579cc2f", "filename": "files/20190411_IN10965_9e933b436f8b2a6d16b364f6d338d5159579cc2f.html", "images": {} }, { "format": "PDF", "encoding": null, "url": "https://www.crs.gov/Reports/pdf/IN10965", "sha1": "387a099aab18263cee3d0b1fee6abc0e148d2f70", "filename": "files/20190411_IN10965_387a099aab18263cee3d0b1fee6abc0e148d2f70.pdf", "images": {} } ], "topics": [ { "source": "IBCList", "id": 4845, "name": "Federal Emergency Management" } ] }, { "source": "EveryCRSReport.com", "id": 589556, "date": "2019-01-08", "retrieved": "2019-01-08T18:07:29.069113", "title": "The National Flood Insurance Program (NFIP), Reinsurance, and Catastrophe Bonds", "summary": "Insurance generally serves to transfer risk from one entity who does not want to bear that risk to another entity that does. An initial insurance purchase, such as homeowners buying a policy to cover damage to their home, however, is often only the first transfer of that risk. The initial (or primary) insurer may then transfer (or cede) some or all of this risk to another company or investor, such as a reinsurer. Reinsurers may also further transfer (or retrocede) risks to other reinsurers. Such risk transfers are, on the whole, a net cost for primary insurers, just as purchasing insurance is a net cost for homeowners. \nThe Homeowner Flood Insurance Affordability Act of 2014 (P.L. 113-89) revised the authority of the National Flood Insurance Program (NFIP) to secure reinsurance from \u201cprivate reinsurance and capital markets.\u201d Risk transfer to the private market could reduce the likelihood of the Federal Emergency Management Agency (FEMA) borrowing from the Treasury to pay claims. In addition, it could allow the NFIP to recognize some of its flood risk up front through premiums it pays for risk transfers rather than after-the-fact borrowing, and could help the NFIP to reduce the volatility of its losses over time. However, because reinsurers charge premiums to compensate for the assumed risk as well as the reinsurers\u2019 costs and profit margins, the primary benefit of reinsurance is to manage risk, not to reduce the NFIP\u2019s long-term fiscal exposure.\nReinsurance\nThe most common form of risk transfer is a primary insurer purchasing coverage for its risks from another (re)insurer. The primary insurer typically continues to service the initial policy, while the reinsurer operates in the background. Reinsurance is particularly important to smaller insurers who may not be large enough to spread local risks that are spatially correlated, such as a storm hitting a particular area, across a broader geographic area. Reinsurers, however, often have the size to diversify risks on a global scale. \nNFIP Reinsurance Purchases \nThe NFIP\u2019s first large reinsurance purchase was in January 2017, when FEMA purchased $1.042 billion of reinsurance for an annual premium of $150 million. The reinsurance covered 26% of losses between $4 and $8 billion arising from a single flooding event. FEMA has paid over $8.7 billion in claims for Hurricane Harvey, triggering a full claim on this reinsurance. \nIn January 2018, FEMA paid a $235 million premium for $1.46 billion reinsurance, structured to cover losses above $4 billion for a single flooding event, covering 18.6% of losses between $4 and $6 billion, and 54.3% of losses between $6 and $8 billion. FEMA has not claimed on this reinsurance. \nCatastrophe Bonds\nIn addition to reinsurance, new forms of \u201calternative\u201d risk transfer have also developed. One category of such instruments are known as insurance linked securities (ILS)\u2014financial instruments whose values are driven by insurance loss events and which transfer major natural disaster risks to capital market investors. The most common form is catastrophe bonds (or cat bonds), which operate somewhat like other bonds, but whose payout is dependent on the occurrence of a particular catastrophe. \nCatastrophe bonds are structured so that payment depends on the occurrence of an event of a defined magnitude or that causes an aggregate insurance loss in excess of a stipulated amount. Only when these specific triggering conditions are met do investors begin to lose their investment. There are three main types of triggers:\nIndemnity\u2014bonds triggered by the losses experienced by the sponsoring insurer following the occurrence of a specified event (e.g., if an insurer\u2019s residential property losses from a hurricane in Florida exceeds $25 million in 2018);\nIndustry Loss\u2014bonds triggered by a predetermined threshold of industry-wide losses following the occurrence of a specified event (e.g., if a total of all insurers\u2019 residential property losses from floods in 2018 exceeds $20 billion); or \nParametric\u2014bonds triggered by physical conditions occurring during a disaster such as wind speed or earthquake size (e.g., if a 25-foot storm surge hit New Orleans in 2018). \nCatastrophe bonds were first used in the mid-1990s following Hurricane Andrew and the Northridge earthquake. The public sector has become increasingly interested in the use of cat bonds. In 2009, Mexico became the first sovereign state to issue cat bonds, and the World Bank is now one of the largest participants in the catastrophe bond market. The New York City Metropolitan Transit Authority issued cat bonds to protect against storm surge. According to the reinsurer Swiss Re, more than $10.5 billion in catastrophe bonds were issued in 2017, with $278.0 billion outstanding overall. \nNFIP and Catastrophe Bonds\nOn August 1, 2018, FEMA entered into its first transfer of NFIP risk to private markets through an ILS transaction, in the form of a three-year agreement with Hannover Re, a reinsurance company. Hannover Re is acting as a \u201ctransformer,\u201d transferring $500 million of the NFIP\u2019s financial risk to the capital markets by sponsoring issuance of an indemnity-triggered cat bond. Hannover Re will indemnify FEMA for a portion of claims for a single qualifying flooding event that occurs between August 1, 2018, and July 31, 2021. The agreement is structured into two tranches. The first provides reinsurance coverage for 3.5% of losses between $5 and $10 billion, and the second for 13% of losses between $7.5 and $10 billion. FEMA paid a premium of $62 million for the first year of coverage. Unlike the earlier reinsurance purchases, which covered all NFIP flood losses, the catastrophe bond applies only to flooding resulting directly or indirectly from a named storm and covers only the 50 states, the District of Columbia, Puerto Rico, and the U.S. Virgin Islands. \nCombined with the January 2018 reinsurance placement, FEMA has transferred $1.96 billion of the NFIP\u2019s flood risk for the 2018 hurricane season to the private sector. A storm comparable to Hurricane Katrina would result in a total loss for the catastrophe bond investors, while a storm comparable to Hurricanes Sandy or Harvey would erode the principal of both tranches but not cause a total payout.", "type": "CRS Insight", "typeId": "INSIGHTS", "active": true, "formats": [ { "format": "HTML", "encoding": "utf-8", "url": "http://www.crs.gov/Reports/IN10965", "sha1": "049332607463202782e04e8bc86c64c5f30c6ba4", "filename": "files/20190108_IN10965_049332607463202782e04e8bc86c64c5f30c6ba4.html", "images": {} }, { "format": "PDF", "encoding": null, "url": "http://www.crs.gov/Reports/pdf/IN10965", "sha1": "7befe24de8ae2fffff39848ef71a370f6165def4", "filename": "files/20190108_IN10965_7befe24de8ae2fffff39848ef71a370f6165def4.pdf", "images": {} } ], "topics": [ { "source": "IBCList", "id": 4845, "name": "Federal Emergency Management" } ] }, { "source": "EveryCRSReport.com", "id": 584926, "date": "2018-09-11", "retrieved": "2018-10-05T22:27:13.089254", "title": "The National Flood Insurance Program (NFIP), Reinsurance, and Catastrophe Bonds", "summary": "Insurance generally serves to transfer risk from one entity who does not want to bear that risk to another entity that does. An initial insurance purchase, such as homeowners buying a policy to cover damage to their home, however, is often only the first transfer of that risk. The initial (or primary) insurer may then transfer (or cede) some or all of this risk to another company or investor, such as a reinsurer. Reinsurers may also further transfer (or retrocede) risks to other reinsurers. Such risk transfers are, on the whole, a net cost for primary insurers, just as purchasing insurance is a net cost for homeowners. \nThe Homeowner Flood Insurance Affordability Act of 2014 (P.L. 113-89) revised the authority of the National Flood Insurance Program (NFIP) to secure reinsurance from \u201cprivate reinsurance and capital markets.\u201d Risk transfer to the private market could reduce the likelihood of the Federal Emergency Management Agency (FEMA) borrowing from the Treasury to pay claims. In addition, it could allow the NFIP to recognize some of its flood risk up front through premiums it pays for risk transfers rather than after-the-fact borrowing, and could help the NFIP to reduce the volatility of its losses over time. However, because reinsurers charge premiums to compensate for the assumed risk as well as the reinsurers\u2019 costs and profit margins, the primary benefit of reinsurance is to manage risk, not to reduce the NFIP\u2019s long-term fiscal exposure.\nReinsurance\nThe most common form of risk transfer is a primary insurer purchasing coverage for its risks from another (re)insurer. The primary insurer typically continues to service the initial policy, while the reinsurer operates in the background. Reinsurance is particularly important to smaller insurers who may not be large enough to spread local risks that are spatially correlated, such as a storm hitting a particular area, across a broader geographic area. Reinsurers, however, often have the size to diversify risks on a global scale. \nNFIP Reinsurance Purchases \nThe NFIP\u2019s first large reinsurance purchase was in January 2017, when FEMA purchased $1.042 billion of reinsurance for an annual premium of $150 million. The reinsurance covered 26% of losses between $4 and $8 billion arising from a single flooding event. FEMA has paid over $8.7 billion in claims for Hurricane Harvey, triggering a full claim on this reinsurance. \nFEMA purchased $1.46 billion of reinsurance in January 2018, for a premium of $235 million. This is structured to cover losses above $4 billion for a single flooding event, covering 18.6% of losses between $4 and $6 billion, and 54.3% of losses between $6 and $8 billion. \nCatastrophe Bonds\nIn addition to reinsurance, new forms of \u201calternative\u201d risk transfer have also developed. One category of such instruments are known as insurance linked securities (ILS)\u2014financial instruments whose values are driven by insurance loss events and which transfer major natural disaster risks to capital market investors. The most common form is catastrophe bonds (or cat bonds), which operate somewhat like other bonds, but whose payout is dependent on the occurrence of a particular catastrophe. \nCatastrophe bonds are structured so that payment depends on the occurrence of an event of a defined magnitude or that causes an aggregate insurance loss in excess of a stipulated amount. Only when these specific triggering conditions are met do investors begin to lose their investment. There are three main types of triggers:\nIndemnity\u2014bonds triggered by the losses experienced by the sponsoring insurer following the occurrence of a specified event (e.g., if an insurer\u2019s residential property losses from a hurricane in Florida exceeds $25 million in 2018);\nIndustry Loss\u2014bonds triggered by a predetermined threshold of industry-wide losses following the occurrence of a specified event (e.g., if a total of all insurers\u2019 residential property losses from floods in 2018 exceeds $20 billion); or \nParametric\u2014bonds triggered by physical conditions occurring during a disaster such as wind speed or earthquake size (e.g., if a 25-foot storm surge hit New Orleans in 2018). \nCatastrophe bonds were first used in the private sector in the mid-1990s following Hurricane Andrew and the Northridge earthquake. The public sector has become increasingly interested in the use of cat bonds. In 2009, Mexico became the first sovereign state to issue cat bonds, and the World Bank is now one of the largest participants in the catastrophe bond market. The New York City Metropolitan Transit Authority issued cat bonds to protect against storm surge. According to the reinsurer Swiss Re, more than $10.5 billion in catastrophe bonds were issued in 2017, with $278.0 billion outstanding overall. \nNFIP and Catastrophe Bonds\nOn August 1, 2018, FEMA entered into its first transfer of NFIP risk to private markets through an ILS transaction, in the form of a three-year agreement with Hannover Re, a reinsurance company. Hannover Re is acting as a \u201ctransformer,\u201d transferring $500 million of the NFIP\u2019s financial risk to the capital markets by sponsoring issuance of an indemnity-triggered cat bond. Hannover Re will indemnify FEMA for a portion of claims for a single qualifying flooding event that occurs between August 1, 2018, and July 31, 2021. The agreement is structured into two tranches. The first provides reinsurance coverage for 3.5% of losses between $5 and $10 billion, and the second for 13% of losses between $7.5 and $10 billion. FEMA paid a premium of $62 million for the first year of coverage. Unlike the earlier reinsurance purchases, which covered all NFIP flood losses, the catastrophe bond applies only to flooding resulting directly or indirectly from a named storm and covers only the 50 states, the District of Columbia, Puerto Rico, and the U.S. Virgin Islands. \nCombined with the January 2018 reinsurance placement, FEMA has transferred $1.96 billion of the NFIP\u2019s flood risk for the 2018 hurricane season to the private sector. A storm comparable to Hurricane Katrina would result in a total loss for the catastrophe bond investors, while a storm comparable to Hurricanes Sandy or Harvey would erode the principal of both tranches but not cause a total payout.", "type": "CRS Insight", "typeId": "INSIGHTS", "active": true, "formats": [ { "format": "HTML", "encoding": "utf-8", "url": "http://www.crs.gov/Reports/IN10965", "sha1": "77cd2b7e5749efa60d21030230fd77d6783e00c2", "filename": "files/20180911_IN10965_77cd2b7e5749efa60d21030230fd77d6783e00c2.html", "images": {} }, { "format": "PDF", "encoding": null, "url": "http://www.crs.gov/Reports/pdf/IN10965", "sha1": "6af72b714f3daa69685427a6be26055a5ca9041e", "filename": "files/20180911_IN10965_6af72b714f3daa69685427a6be26055a5ca9041e.pdf", "images": {} } ], "topics": [ { "source": "IBCList", "id": 4845, "name": "Federal Emergency Management" } ] } ], "topics": [ "Economic Policy" ] }